JP Morgan Asset Management’s Iain Stealey sees rising yields in Japan
Iain Stealey, portfolio manager on the Global Multi-Sector Income Strategy at JP Morgan Asset Management, says efforts to effect inflation in Japan is pushing JGB yields higher.
Firmer US data prints and renewed interest in the Federal Reserve’s exit strategy from its bond buying programme caused core government bond underperformance last week. This has been magnified in Japan where USDJPY breaking through 100 pushed the Nikkei and Japanese Government Bond (JGBs) yields higher. Since the 4th of April, when the Bank of Japan (BOJ) announced an aggressive monetary policy target of 2in2 (2% inflation in two years time), 10yr JGB yields have more than doubled from an intra-day low of 0.33% to 0.85% today.
Given the amount of JGBs the BOJ has committed to buying (70% of gross issuance, over 100% of net issuance), an expectation of lower JGB yields might appear reasonable. But with the BOJ explicitly aiming to raise inflation expectations, the initial knee jerk reaction of lower yields has been replaced with a realisation that higher inflation is the enemy of a bond investor. You only need to look back to the periods following the QE1 and QE2 announcements by the Federal Reserve and the reaction of the US Treasury Bond market to see this in action.
For an economy mired in deflation for the last 15 years, owning JGBs even at low yields has delivered positive real returns. There remains significant scepticism that the BOJ will be able to engineer their 2in2 target, but for the time being, the market appears to be giving them the benefit of the doubt. One of the consequences of raising inflation expectations could be higher bond yields, which would be seen as undesirable by the BOJ as they will want JGB yields to remain low to aid the recovery. Yesterday the BOJ did intervene to stabilise the market.
For the last few years there have been numerous discussions about the road map for western developed economies being Japan; a “lost decade” with government bond yields remaining lower for longer. There is now a debate as to whether the BOJ would actually like the road map for Japan to be that of other developed economies; inflation higher than government bond yields…negative real yields…